Banks agree to European CDS clearer

Weeks of battling between regulators in Brussels and some of the biggest players in the huge $60,000bn credit derivatives industry ended on Thursday when the industry agreed to clear most EU-based credit default swap contracts in Europe.

The decision, which envisages that European-based clearing could be up and running within six months, was immediately welcomed by senior EU officials.

In the wake of the financial crisis, European regulators have been arguing that centralised clearing is essential to mitigate risks attached to credit default swaps, the main type of credit derivatives, and give more transparency to the market.

CDS contracts are designed to provide insurance against bond defaults. Their use ballooned ahead of the recent turmoil but they have mainly been traded on a one-to-one basis between dealers and financial institutions, rather than through a centralised counterparty system.

Officials at the European Commission began talks with banks and financial services groups on centralised clearing for CDS last autumn – mirroring similar moves in the US. But the European talks broke down in January, in a dispute over timing and whether a “global” solution was preferable to one which was EU-based.

Commission officials insisted that the latter was essential for transparency reasons, while the International Swaps and Derivatives Association – which represents many of the big investment banks and leading dealer firms – preferred the former.

But this morning, ISDA said that nine members were now prepared to commit to the use of central counterparty clearing for CDS in the EU. The firms – Barclays Capital, Citigroup Global Markets, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JP Morgan, Morgan Stanley and UBS – have all signed a letter confirming that they will use EU-based clearing for eligible contracts by the end of July this year.

The European Banking Federation, which represents many of Europe’s top banks, has also provided a similar commitment.

The change of heart by ISDA’s members comes in the wake of a threat by Brussels to bring in legislation which could force banks to hold more capital against uncleared contracts. Although it was never certain that such measures would have been adopted, as required, by both the European Parliament and member states, they do appear to have seriously worried some firms.

Today’s pact does not resolve the question of where – within the EU – CDS clearing will now take place. Four exchanges are vying for this business, two in London and two within the eurozone. The EBF has said publicly that it is agnostic on this issue, but the European Central Bank has suggested that it would like to see a eurozone solution.

Officials in Brussels said that this was a matter for the industry to resolve.

19 Feb 2009 2:27pm
By Nikki Tait in Brussels and Jeremy Grant in London